*Editor’s note: Guest post by Brian Jacobs, Co-founder and General Partner at Emergence Capital. Emergence Capital is a leading venture capital firm focused on cloud companies. Brian serves on the boards of: Intacct, Bill.com, InsideView, Donuts, Hightail, Janrain and Drivewyze. You can follow Brian at @brian_emcap.
In the venture capital world, everyone talks about traction – but what does it mean? Why, as a company, do you need it and how do you get it?
After a winter full of blizzards, drivers all over the country were stuck or stranded on icy roads. They knew that good traction was needed to effectively control a car. Without traction, you simply spin your wheels and expel energy but ultimately get nowhere.
Traction is important to VCs because we want to know if we are investing in: (a) a company that can reasonably control its revenue generation, often as a function of investment in sales and marketing, or (b) a company that may be on the cusp of lining up the elements needed for consistent revenue growth, but cannot yet reliably predict or control revenue generation. Many VCs will only invest when they believe you have traction or are close to finding it, because the best returns come from investing ‘just prior to’ or ‘just after’ the inflection point. Real customer traction will enable you to attract more capital from a wider pool of venture capital investors.
We have been focused on SaaS for over 10 years, and we have had the chance to meet a lot of growing companies and compare metrics and patterns. We have learned the patterns of success from the early metrics for market leaders in the Emergence portfolio such as Salesforce.com, SuccessFactors, Yammer and Veeva Systems. We have developed five indicators of traction that we look for in investments:
1. Accelerating Bookings
Often, rapidly growing bookings seem to show strong traction. This is a necessary, but not a sufficient condition because we look for indicators of sustainable traction. We separate new and renewal bookings, and we separate out professional services, campaigns, and non-recurring project revenue. These are all important metrics, but to understand traction we focus on the trajectory of new customer bookings measured by annual contract value, or “ACV” or monthly recurring revenue, or “MRR” – not total contract value, or “TCV.” Predictability is often more important that the growth rate.
2. Evidence of Price/Value
Selling SaaS solutions is hard, so we look at both deal sizes and how compelling the company’s solutions are to its customers. Our expectations depend on the target customer, but we are impressed when annual contract values exceed $150k+ for enterprise; $75k+ for mid-market; and $25k+ for SMB (small & medium businesses).
3. Efficient Customer Acquisition
VCs prefer to invest in efficient growth: getting a lot of revenue per dollar of new investment. We compare the total customer acquisition cost (CAC), usually total sales and marketing costs, with new ACV bookings. We prefer a ratio under 1.0 because it suggests customer payback will start happening prior to year 2. Some companies find unique ways to create an efficient sales model such as channel partners or freemium models that generate viral growth.
4. Positive Customer References
We always call a sample of customers, usually 5 to 10. Most customers will say positive things about the product and the company, but we are listening for clues that tell us more:
- Does the application solve a truly important need? Is it critical to the customer’s business, or is it a “nice-to-have”?
- Do they describe benefits that match the company’s sustainable competitive advantage?
- Has the implementation moved beyond pilots and trials?
- Has the customer evaluated the competitive products?
- Is the customer planning to renew and expand usage in the future?
- How did the customer learn of the product?
- Does the customer have a prior relationship with the founder?
Sometimes we find unusually strong “customer love” which is a great sign, but not the only indicator of traction.
5. Growing Pipeline
It’s great to sign a big deal or have a great quarter, but momentum comes from consistently signing big deals and having great quarters. The only way to really gain that kind of traction is to build the infrastructure that can produce a pipeline of prospects and a process for converting them. This is difficult for a lot of startups because there aren’t many shortcuts. Building a quality pipeline may involve lead generation, marketing automation, CRM, and content marketing. VCs can help you scale up your pipeline management processes, but companies shouldn’t wait for a VC to start building these processes.
Entrepreneurs who already have traction should find a lot of interest from VCs. Money is plentiful for companies that can reliably accelerate sales. Without customer traction, entrepreneurs should focus fundraising efforts on angel investors and seed funds or VCs who explicitly seek to help pre-revenue companies develop the demonstrable traction they’ll need to raise further capital. Ask prospective investors about the criteria above to evaluate whether they can help. Once you start to see that traction, you will have the momentum to attract a wider array of investors.